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Apple found per se liable in a hub-and-spoke conspiracy with e-book publishers

Last week, Apple was found by a court in the Southern District of New York to have engaged in a per se illegal horizontal price-fixing conspiracy with five of the six top national book publishers to raise the price of e-books.1 The court found that Apple effectively engaged in a "hub-and-spoke conspiracy," i.e., Apple (acting as the hub) effectively facilitated and encouraged a horizontal agreement among the publishers (the spokes) to fix prices through a series of vertical agreements (containing MFN clauses) between Apple and each of the publishers. Although the court found Apple liable under a per se standard, the court indicated that it would have also found Apple liable under a rule of reason standard and rejected Apple’s assertion that its actions had the procompetitive effect of introducing competition (through Apple’s entry) in the e-books market then allegedly dominated by Amazon.

Key Takeaways

Despite the growing trend of courts to limit the application of per se rules to facially anticompetitive horizontal agreements (like price-fixing) and increasingly evaluate vertical agreements under the rule of reason, the court was willing to condemn Apple’s vertical conduct as per se illegal once it found that its purpose and effect was to orchestrate a horizontal conspiracy among the publishers.

Although Apple’s use of Most-Favored-Nation (“MFN”) clauses was found to be a central part of the conspiracy, it is not “open season” on MFNs. Rather, the MFN was one aspect of the overall course of conduct and understanding between Apple and the publishers. That said, MFNs can raise antitrust issues2 and one risk factor to consider is whether an MFN is being used to facilitate collusion.

Courts are highly swayed by evidence found in company documents and statements made by company executives. Certain statements and emails by Apple executives featured prominently in the court’s analysis of Apple’s knowledge of its facilitating role in the conspiracy.

The court appeared heavily swayed by the fact that prices rose following the publisher’s shift to the agency model and the fact that, at least in the short term, publishers’ revenues were expected to decline under the Apple agreements.

Background

Apple began offering e-books in January 2010 with the launch of its iPad and iBookstore. In April 2012, the United States Department of Justice (“DOJ”) sued Apple and five of the largest e-book publishers, alleging they conspired to raise prices for e-books by agreeing to move away from the existing wholesale model, in which the retailer set the price of e-books, to an “agency model,” in which the publishers were able to set retail prices.3 The DOJ alleged the publishers favored the agency model because Amazon’s low pricing of e-books under the wholesale model was pressuring prices on printed books. Moreover, Amazon’s strength in e-book publishing had the potential to remove the publishers as intermediaries in the supply chain altogether. The DOJ further maintained Amazon’s alleged dominance in the e-book market meant that no individual publisher would find it profitable to move to the agency model on its own and risk retaliation by Amazon. Accordingly, the publishers allegedly signaled to each other the terms they found acceptable, using Apple as the central coordinator. The DOJ complaint also alleged significant direct contacts among the publishers.

A key term of the publishers’ agreement with Apple was an MFN barring the sale of e-books on other retail platforms at prices below those in Apple’s iBookstore. Based on the terms of their agency agreements with Apple (including the MFN) the publishers had the incentive to force Amazon and all other retailers to the agency model. The Apple agreements allegedly had the immediate effect of shifting prices upward, in some cases by 50% or more, by ending Amazon’s ability to price at will.

The five publishers each settled with the DOJ agreeing to terminate their agency agreements (and make certain other commitments).4 Apple alone chose to litigate.

District Court Analysis

The court held Apple per se liable based on what was characterized as “overwhelming facts” evidencing that the publishers participated in a horizontal price-fixing conspiracy and that Apple was a knowing, willing and active member of the conspiracy. Per se liability is normally limited to hard core antitrust violations such as price fixing and bid rigging. In contrast, vertical price restraints that do not involve price fixing are subject to the rule of reason which balances the pro-competitive effects of a restraint against the anticompetitive effects to determine which predominate. However, following Toys “R” Us, Inc. v. FTC,5 per se price-fixing agreements also include agreements in which a vertical player participates in and facilitates a horizontal conspiracy.

Evidence of Conspiracy

The court rejected Apple’s assertion that it was focused solely on accomplishing its unilateral business objectives of providing the best e-book reading experience for customers and therefore Apple had no intent to conspire with the publishers. The court found “overwhelming [evidence] that Apple knew of the unlawful aims of the conspiracy and joined that conspiracy with the specific intent to help it succeed.” The court placed significant emphasis on the statements of Apple executives. Such evidence included Apple’s then CEO, Steve Jobs, responding to a reporter’s question upon the iPad’s launch regarding why people would pay more at the iBookstore when Amazon sells the same e-book for less by saying, “Well, that won’t be the case” and “The price will be the same.”

Vertical Nature of Relationship with Publishers

The fact that Apple was in a vertical rather than a horizontal relationship with the publishers was found insufficient by the court to exonerate Apple of per se liability or to merit rule of reason analysis. The court believed that per se treatment was warranted because, in its view, there was “compelling direct and circumstantial evidence” that demonstrated Apple was a knowing participant in the publishers’ horizontal conspiracy. Further, the court went on to note that “[i]f it were necessary to analyze this evidence under the rule of reason, however, the plaintiffs would also prevail.”

MFN

The court rejected Apple’s assertion that its sole intention in seeking the MFN was to protect itself (not the publishers). It found that Apple had multiple motivations for including the MFN and that while the MFN would result in lower prices if publishers did not move other retailers to an agency model, the MFN at the same time ensured that the publishers would have the incentive to force their retailers to adopt the agency model. However, the court was careful to point out that the decision does not imply MFN clauses are necessarily improper, rather that the use of the MFN by Apple to facilitate the conspiracy was improper.

Role of Apple's Entry

Finally, the court discounted Apple’s argument that a verdict against it would chill future entry and innovation. According to the court, Apple did not provide evidence of any pro-competitive effects arising specifically from its agreements with the publishers and found that the launch of the iPad only tangentially related to Apple’s conduct. The court also noted that the question of whether Amazon’s monopoly pricing practices violate the antitrust laws was not at issue here and either way would not justify Apple’s engagement in anticompetitive behavior. In addition, Judge Cote rejected Apple’s contention that hub-and-spoke conspiracy does not apply when a defendant is a new market entrant and not a dominant player.

Going Forward

Given the many unique facts and circumstances at play in the case, we do not believe it represents a judicial shift in hostility to MFNs. In the end, the e-books decision simply reaffirms the sound advice to always think carefully about how corporate conduct is characterized and captured in business documents so as to avoid future misinterpretations about the company’s motives for pursuing a particular course of action.

Apple has announced it will appeal the decision.

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